DB transfer shouldn’t be all-or-nothing

By Steve Webb, director of policy

In my recent discussions with advisers, a hot topic has been the growing number of people interested in transferring their defined benefit pension rights into a defined contribution pension scheme.

With many pension schemes offering eye-watering transfer values, this is likely to be an area of increasing interest. Yet many advisers, for understandable reasons, are very reluctant to get too involved in this area. So how can we get to a situation where people can access high-quality, well-informed advice so that the ‘right’ people transfer and the ‘wrong’ people do not?

At first glance, encouraging DB-to-DC transfers feels like it could be a win-win-win for DB schemes, scheme members and the Government.

For the scheme, it offers a chance to de-risk and thereby reduce the volatility of the DB deficit figure on the balance sheet of the sponsoring employer.

For the scheme member, transfer values have never been higher. For example, I recently met an adviser whose client had seen their transfer value increase over the past year by more than the value of the average house in the UK.

For workers in particular situations – perhaps who fear that their sponsoring employer will go bust and the scheme end up in the Pension Protection Fund, or those in poorer health who may prefer cash now to a lifetime pension, or those who want to pass on part of the value of their pension rights to the next generation – a transfer out with a good transfer value could be very attractive.

And for the Government, if people exchange an income for life for a lump sum and then draw down more rapidly than they would otherwise have done, there is a potential boost to up-front tax revenues, just as with the original ‘freedom and choice’ reforms.

So, if there are all these potential upsides, what is there to worry about?

The first concern is that individuals may be seduced by the huge cash sums being offered into giving up something very valuable – a guaranteed income for life, with a measure of protection against inflation and a pension for a surviving spouse. If savers are blinded by the lump sum on offer, they may be tempted to transfer out, only to live to regret it.

The obvious antidote to this would be a ready supply of high-quality impartial advice. But here the situation is problematic. Some advisers simply refuse to take on this work for fear of subsequent litigation or the problems of having to deal with ‘insistent’ clients. Those advisers who are willing to do work in this area find that their professional indemnity insurance costs can rise and live in fear of retrospective challenge – both from savers who transfer and later conclude that they shouldn’t have done so, and from those who do not transfer (having taken advice) and later decide that it would have been better if they had. Advisers could be forgiven for thinking that they will be damned either way.

One half-way house that would reduce the risks all around but also provide greater flexibility is if partial DB transfers were more readily available. DB schemes may well object to the increased administrative cost of allowing partial transfers – or perhaps providing a ‘menu with prices’ where scheme members can choose how much of their DB rights they want to transfer out. But if such transfers were much less of an all-or-nothing choice, take-up might be much greater, to the benefit of the scheme. In this case, members could retain a guaranteed index-linked income as a floor for their retirement saving but could also enjoy the greater ‘freedom and choice’ to turn income into capital that DC savers already enjoy.

Ideally, there would be a regulatory regime that provided a safe environment in which advisers could service this market. But the current process with its focus on ‘critical yields’ was designed very much with the world of the annuity in mind. Given that many people who have built up large cash-equivalent transfer values have no intention of buying an annuity and are more likely to go for a mixture of drawdown and withdrawing cash, this seems to be the wrong benchmark for comparison.

Although there is a lot in the FCA’s in-tray, the regulatory framework for advising on DB-to-DC transfers needs to be refreshed as a matter of urgency.